Regulatory Tracker

The Securities and Exchange Commission (SEC) is in the process of updating its regulatory rules on money market mutual funds. These funds invest in high-quality and short-term debt instruments, such as Treasury bills and commercial paper. During the recent financial crisis, many money market funds had liquidity problems, and the SEC is now considering a number of wide-ranging reform proposals to strengthen the regulatory framework for these funds.

RULE 12B-1 FEESThe Securities and Exchange Commission (SEC) is considering several regulatory proposals to reform its Rule 12b-1. Under this Rule, a mutual fund may compensate brokers and other financial intermediaries from investor assets for specific activities related to the sales and distribution of fund shares.

HIDDEN OMNIBUS ACCOUNTSBroker-dealers and other financial intermediaries use a business practice called omnibus accounts to generate additional fees from mutual funds and their investors for certain shareholder servicing and recordkeeping activities. Individual investor information needed to enforce mutual fund prospectus policies is hidden from the funds and many of the fees being paid to these financial intermediaries are unnecessary and costly for investors.

SECTION 529 COLLEGE SAVINGS PLANSSection 529 of the Internal Revenue Code authorizes individual States to establish programs to help people save for future college expenses. In the wake of the recent financial crisis, several large broker-dealers are trying to move individual Section 529 accounts onto their own recordkeeping systems for the purpose of extracting additional fees from mutual funds and investors.

MARKET TIMING AND OTHER TRADING ABUSESBeginning in the summer of 2003, the SEC and several State regulators initiated investigations into improper arbitrage and other trading activities by more than 30 mutual fund complexes. The SEC promulgated new rules to address these short-term trading abuses, but it has not yet found an acceptable solution to market timing activities within omnibus accounts controlled by broker-dealers and other third-party financial intermediaries.

INVESTOR RESTITUTION PAYMENTSAs a result of investigations and enforcement actions initiated by the SEC and several State regulators in 2003-2005, as much as $3.5 billion has been collected in penalties and fines from more than 30 mutual fund complexes for improper market timing and late trading activities. Under the SEC's Fair Fund program, the monies which have been collected are in the process of being distributed to millions of individual investors who were harmed by these trading activities. As a public service, CMFI monitors this SEC distribution process and prepares a periodic status report for investors interested in tracking these restitution payments.

BROKER SALES LOAD DISCOUNTSMany mutual funds offer volume or "breakpoint" discounts to shareholders who are charged a sales load for their purchases of fund shares. Over the past decade, every study that examined breakpoint discount transactions concluded that investors are being overcharged these sales commissions. This problem can be fixed by increasing the transparency within omnibus accounts controlled by broker-dealers.

PAY TO PLAY RESTRICTIONS ON MUTUAL FUND ADVISERSNew SEC regulations attempt to address "pay-to-play" practices by investment advisers and their government clients. These new rules impose detailed reporting and recordkeeping requirements on investment advisers. Mutual fund advisers are not able to comply with these rules because certain investor-level account information is controlled exclusively by broker-dealers using omnibus accounting platforms. CMFI and other groups are calling on the SEC to fix this problem through measures that increase the transparency of information within these hidden accounts.

MUTUAL FUND RETIREMENT PLAN ISSUESThe U.S. Labor Department has regulatory jurisdiction over many retirement plan issues, as a result of the Employee Retirement Income Security Act of 1974 (ERISA). Over the past several years, the Labor Department has issued new regulations affecting 401(k) plans and other types of retirement vehicles for individual investors. More recently, the Department has proposed a new regulation that modernizes the current definition of "fiduciary," for persons providing investment advice for a fee to a retirement plan or to an individual account.

BROKER-DEALER FEE PRACTICESCMFI has documented several practices being used by large broker-dealers to increase their revenues from mutual fund activities. CMFI estimates that these practices are imposing annual costs on individual investors of as much as: (1) $2.2 billion in account maintenance charges; (2) $4.18 billion in shareholder servicing payments; and (3) $2.09 billion in revenue-sharing payments. These fees are established without competitive bidding processes and are being charged despite the fact that securities issuers do not normally pay broker-dealers to hold positions in individual accounts for other types of investments, such as stocks, bonds, and ETFs.

MUTUAL FUND TRANSACTION COSTSUnder current SEC rules and Generally Accepted Accounting Principles (GAAP), the brokerage commissions actually paid by a mutual fund are not disclosed as an operating expense or in the expense ratio calculation provided to investors. Instead, the cash amount paid for brokerage commissions is disclosed annually in a fund's Statement of Additional Information. Unfortunately, this number has little value to an investor unless it is compared to the average net assets of a fund and converted into a percentage ratio. CMFI has recommended that the SEC approve a formula to calculate and disclose a transaction cost ratio--separate from the expense ratio--so that investors are provided with an estimate of a mutual fund's annual transaction costs.

MUTUAL FUND GOVERNANCE ISSUESIn July 2004, the SEC promulgated final regulations to improve the governance of mutual funds. One of these new rules required that mutual fund boards have no fewer than 75 percent independent directors. Another rule required that each mutual fund be chaired by an independent director. These two requirements were successfully challenged in court by the mutual fund industry and the SEC has not issued a new final rule. However, the substantial majority of mutual fund boards have voluntarily adopted these two standards of 75 percent independent directors and an independent board chairman.

STANDARDS FOR BROKER-DEALER ADVICE TO INVESTORSUnder current SEC rules, investment advisers and broker-dealers are subject to different standards of care when providing personalized investment advice to individual investors. The Investment Advisers Act requires an investment adviser to serve in a fiduciary capacity, with a duty to act in the best interests of its clients. A broker-dealer, on the other hand, is subject to a lesser "suitability" standard, requiring a broker-dealer only to make recommendations that are consistent with the interests of its customer. The SEC has released a comprehensive study on this issue and is expected to initate a rulemaking in the near future.

DISCLOSURES TO INVESTORS AT POINT OF SALEThe SEC initiated a rulemaking in 2004 to improve the disclosures made to investors by broker-dealers about their costs and conflicts of interest in distributing mutual fund shares. This proposal rule would have required these disclosures at the point-of-sale and in transaction confirmations. The SEC also has moved forward with a rulemaking to permit mutual funds to send investors a "summary" prospectus, with the most important information about a fund in a more concise format that the longer prospectus that a fund files with the SEC. After receiving a summary prospectus, an investor can obtain more detailed information about a fund by accessing the full prospectus and the Statement of Additional Information on a fund's website.

OTHER MUTUAL FUND ISSUESAfter the recent market timing and late trading investigations of the mutual fund industry, the SEC initiated a series of rulemakings to address several outsanding issues. These new rules would: (1) require each registered investment adviser to create a code of ethics; (2) prohibit mutual funds from paying for the distribution of their shares with brokerage commissions; (3) require additional disclosures about how fund boards approve investment advisory contracts; and (4) enhance disclosures about mutual fund portfolio managers. All of these rulemakings were conducted and finalized in 2004.

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